(MONEY Magazine) – Here's just one big problem with the record-setting stock market: As stock prices keep spiraling to ever-dizzying heights, it gets harder to find equities that aren't wildly overvalued--and even more difficult to resist the temptation to buy popular but very expensive stocks. (Microsoft, anyone?)

"Ideally," says Robert Haugen, professor of finance at the University of California at Irvine, "you'd like to invest in a low-risk, liquid, big, highly profitable, fast-growing company selling at a cheap price." There's only one catch, he notes: "No single stock fits that profile." So instead, the best course of action is sizing up a stock against a range of benchmarks to decide whether its price fairly represents the benefits that would accrue to you as a shareholder. "Whether a company's shares are selling at $10 or $110 today, you need to compare that price to the firm's current economic performance--that is, growth of sales and earnings, market share dominance, new-product development--and its potential to see whether there is value to investing in it," says Bernadette Murphy, shown on page B1, a technical analyst at Kimelman & Baird in New York City. So here is the short course on five of the most important stock-price benchmarks and what each tells you about the price you should pay when investing today:

--Historical price. You've heard the old saw that past performance is no guarantee of future results, but a stock's trading pattern for the past 12 months as shown on a price/volume chart can be quite informative. These graphs plot a stock's price and trading volume history together, so you can quickly see the dollar levels where buying has increased or tapered off over time. You can find them in Value Line Investment Survey, which is available at many local libraries or online at http: //www.zacks.com.

Such charts provide two important pieces of data. First, you can see where the stock is trading now, compared with its price over the past year. If the stock is currently selling below its 12-month high, it may have more room to rise than shares that have been setting new highs. In other words, you won't buy in at the top. Second, any recent sharp increases in trading volume tell you that other investors are getting interested in your stock. But if you notice volume movement while the price has been trailing off, that's a sign that investors think the shares are overvalued and a selling stampede may be around the corner.

"Many stocks move in cycles formed by steps," says Murphy. "When a stock price begins to climb out of a range that it has established and trading volume starts to increase, that's a signal to me that the stock is starting an advance." It will pause periodically, she notes, as some investors take profits, but that pit stop will give the company's earnings and sales growth figures time to catch up with its price. Murphy sees Northwest Natural Gas (ticker symbol: NWNG; recently traded on the New York Stock Exchange at $26; 4.7% yield) as emerging from such a consolidation period with strong growth still ahead. The $400 million Portland, Ore.-based natural gas utility had seesawed between $23.25 and $25.25 from January through May. Following a spike in volume in the last week in May, the price has risen to $26.

--Price in relation to earnings per share. You're already familiar with P/E, which measures a company's price relative to its most important performance statistic, its earnings per share. Traditionally, investors compare a company's P/E, also known as the earnings multiple, with that of the overall market as represented by Standard & Poor's 500-stock index, and to the average P/E of outfits in the same industry as well as the firm's own projected earnings growth rate. If the P/E is higher than any of these, it's a sign the stock may be overpriced.

There are two key trends to keep in mind when looking at P/Es today. First, as MONEY reported in March 1997 (see "The Real Dow"), the earnings of many large U.S. corporations have been inflated by as much as 20% lately because they do not include huge restructuring charges taken for layoffs and failed ventures. Therefore, you should add one or two points to the P/Es of companies that have had big write-offs in the past few years. These charges are itemized in a company's annual report.

Second, investors tend to project today's conditions too far out into the future, assuming a company that looks good today will look just as good tomorrow or in five years. Indeed, while high-quality stocks have sold at multiples of around 14 in the past, today's optimistic investors are so confident that the trend to higher earnings will continue that they have bid up the P/E of the S&P 500 to a pricey 22.2 times earnings.

Rose-colored glasses can really distort the prospects of stocks with high earnings growth projections. The more a stock's projected growth rate differs from the average for all companies, which MONEY's investment strategist Michael Sivy estimates at just under 10% this year, the more room its price has to diverge from how analysts think it will behave. And today's investors are willing to pay so much for earnings growth that the slightest disappointment in reported earnings can pummel the price. Bottom line: There is not much margin for error when forecasted growth rates leave the ozone layer. So to play it safe, be cautious about buying any stock that analysts predict will see more than 25% annual earnings growth. That means in turn that a stock with a P/E ratio above 25 may be too expensive to buy right now--no matter what its projected earnings growth is supposed to be.

Instead, focus on more stable companies with projected earnings growth rates that are modestly above average or price/earnings ratios that are slightly below average. Just such a jewel is Intel (INTC; Nasdaq, $88.50; 0.1% yield). The $28 billion Santa Clara, Calif. semiconductor giant may seem a bit expensive, especially considering that it sold for just under $70 (on a split-adjusted basis) at the beginning of July. But Intel makes the microprocessors that run more than 90% of the world's personal computers and is set to enjoy annual earnings growth of at least 15% over the next three to five years, according to Scott Black, president of Delphi Management in Boston. Meanwhile, the stock trades at only 20 times its estimated 1997 earnings. "Intel is a high-tech blue chip," Black says. "It's the one large-cap technology stock with both staying power and a reasonable price."

The only exceptions you might make to the rule of shunning high-P/E, high-growth stocks are for financially sound companies that are so dominant in their markets (or so protected by government regulation) that potential rivals face almost insurmountable barriers to entry.

For example, Medtronic (MDT; NYSE, $90.50; 0.5%), currently has a P/E of 35. But the $2.8 billion Minneapolis manufacturer of pacemakers and other implantable medical devices rules the world market for pacemakers with a 50% share, twice that of its nearest competitor. And it has the financial muscle--22% profit margin, $400 million in free cash, low debt--to keep investors' hearts pounding. As a result, Jon Osgood, an analyst at Alex. Brown & Sons in Boston, sees the firm's earnings growing at an annual clip of 20%.

--Price in relation to sales per share. For some types of companies, earnings growth is only part of the picture. Profits vary widely from year to year for firms in cyclical industries like mining, autos and housing, either because they have huge fixed costs or they are sensitive to interest rates. But revenues for these companies tend to be more stable, so you should compare their stock prices with sales figures. You derive the price-to-sales ratio, or P/S, by dividing the current stock price by the company's revenues per share for the past year. A value of 1 means that you are paying $1 for every dollar in sales the firm generates. A ratio of 0.9 or more is considered high--that is, the stock is overvalued--while a ratio of 0.65 or less is low.

Now, here's where you have to be careful: If a company has a low P/S multiple and an average or high P/E multiple, it will have a low ratio of earnings to sales. Translation: It's having trouble generating profits. Such an outfit may be a bargain--if you have reason to believe that it will rebound. But it can also be a dog, so you must look for signs that the firm is due to bounce back. If a company is merely in a depressed part of its business cycle, for example, or you expect that management changes will lead to better margins, a low P/S could signal a buying opportunity.

For instance, in early July, International Paper (IP; NYSE, $56.50; 1.8%), the world's largest paper and forest-products company ($20 billion in revenues), had a P/S of 0.75 but an astronomical P/E of 50. Did that make the Purchase, N.Y. firm a buy or a bust? "A buy," says Chip Dillon, an analyst at Salomon Bros. "IP's management has been taking steps to improve margins." One of them was the July 8 announcement that IP would lop off $1 billion worth of weak business most likely by the middle of 1998. Within three days, its stock soared more than $6, to $57.25, an increase of 12%. Moreover, adds Dillon, who still rates the stock a buy, "By this fall, paper and pulp prices should start to recover from their cyclical troughs and continue to rise for the next two or three years."

--Price in relation to book value per share. This ratio is useful for evaluating companies whose worth principally resides in physical property like factories, as opposed to intangibles like patents. A company's book value, as you probably know, is the net of its assets minus its liabilities, and price-to-book value, or P/B, tells you how many dollars you are paying for $1 of a firm's net value. On average, investors pay from $3.50 to $4 for each dollar of book value per share, or a price of 3.5 to 4 times book value.

A low price-to-book multiple can indicate that a company is a bargain, because companies with low P/Bs typically have abundant assets that are not being exploited. As an example, Richard Howard, a portfolio manager at T. Rowe Price, cites Overseas Shipholding Group (OSG; NYSE, $22.75; 2.6%), a $525 million shipping company in New York City. The shipping industry as a whole has seen rough waters lately, and OSG is selling at a foamy 65 times earnings because its projected earnings are a severely depressed 35 [cents] a share. There hasn't been a great deal of business for OSG's big dry-bulk container ships lately. But demand is picking up, and Value Line estimates that 1998 earnings will be 85 [cents] a share. Meanwhile, the company's price-to-book-value ratio is a mere 1 to 1. Says Howard: "It's a great example of how a low P/B figure suggests a good stock to buy, because although OSG is not converting assets into earnings now, it soon will. For example, it has recently shed about $250 million of underperforming leisure-cruise lines."

--Price in relation to research-and-development spending per share. Earnings, sales and book-value measures all come up short when you need to figure a fast-growing technology company's worth. That's because with tech firms, products become obsolete faster than you can say DOS. What's more, sales and earnings are volatile, and the company assets roar off at night in their turbocharged Porsche 911s. Since these outfits spend heavily on research and development just to stay in business, Michael Murphy, editor of the California Technology Stock Letter ($295 for 24 issues a year; 800-998-2875), adds the amount a tech firm spends on R&D (a figure you can find in its annual report) to its earnings and divides the total by the shares outstanding. This gives him a number he calls the growth-flow measure, the denominator for a price-to-growth-flow ratio. "What really belongs to shareholders isn't just earnings," Murphy says, "but R&D too, because that's what generates future products and future earnings."

The average technology stock typically trades at a price of about 12 times its growth flow. But the more a company spends on R&D, the lower its price-to-growth-flow ratio. A P/GF multiple of 8 or less means the stock is undervalued relative to the company's spending on research and development, according to Murphy. Although a tech stock's P/E may be steep--many of them sure are now--a low price-to-growth-flow number says the company may well eventually produce the products that will support that lofty earnings multiple.

To prove his point, Murphy cites Cirrus Logic (CRUS; Nasdaq, $12.75; no yield), a $1.1 billion Fremont, Calif. manufacturer of complex semiconductors that generate audio and graphics for computers. Cirrus has reported losses in four of the past eight quarters, and based on earnings forecasts of 42 [cents] a share this year, its P/E is an airy 30. Its P/GF, however is only 3.3. "Cirrus plans to spend $230 million, or $3.46 a share, on R&D this fiscal year," Murphy says. "That's a huge commitment. The company could easily slash research, shift $3 a share to profits and watch its price go up. But it wants to bring out new high-quality products instead, which will be better for Cirrus and its investors in the long run." For a look at Cirrus' historical growth flow, see the chart on page B5.

Unfortunately, growth-flow investing can lead you to companies that pour all their resources into products that never see the light of day. To be sure that won't happen, Murphy recommends speaking to someone in the investor relations department of a tech outfit you are researching and asking what percentage of the firm's revenues comes from products that have been introduced in the past three years. "You want a figure of at least 50% to see that the R&D has been successful," he says.

In the end, you can't invest solely by the numbers any more than you can paint that way. But these five benchmarks can steer you away from stocks that are peaking and toward those that are undervalued. Then you need to weigh each ratio carefully, taking them all into account to determine whether, as Bob Barker might say, the price is right.

Reporter associate: Luis Fernando Llosa